Penalty/Liquidated Damages Clauses

The Supreme Court has recently re-written the rules on penalty/liquidated damages clauses.

Gone is the old test of whether a clause reflects a genuine pre-estimate inthe event of breach (which was enforceable) rather than intending todeter a breach (which was not).

The new test is whether a clause gives rise to a consequence out of all proportion to the harmed party's legitimate interest (even if also potentially being penal). If not it will stand. If so it will be unenforceable. What constitutes a legitimate interest will be determined on a case by case basis.

So we move away from looking at whether a clause is aimed at deterring breach to looking at whether it seeks to providecompensation in the event of breach out of all proportion to the innocent party's legitimate interest. It is worth noting that the fact that a clause is not a genuine pre-estimate of loss will not simply mean that it is penal.

Each case requires consideration of the circumstances in which a contract was made and the nature of the parties respective positions when considering the nature of a clause. In a negotiated contract between advised parties of comparable bargaining power the initial presumption will be that the parties were the best judges of what could be legitimate in the event of breach. Where the parties are not “equal” in bargaining position or a clause is not negotiated but imposed there is more scope for argument.

Please note that these notes should not be relied upon as legal advice or an interpretation and application of the law to particular circumstances or matters.

The material in these notes has been designed solely for the purpose of giving general guidance. The material does not stand on its own and is not intended to be relied upon for giving specific advice.

To the fullest extent permitted by law, Gisby Harrison will not be liable by reason of any breach of contract, negligence or otherwise for loss or damage (whether direct or indirect) occasioned to any person acting or omitting to act or refraining from acting on these notes or any error or omission in the notes.

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